Trusts and federal income tax liability

On behalf of Michael A. Manna & Associates posted in Trusts on Friday, December 30, 2011.

Our readers have likely heard of the possibility of going with trust-based estate plan and the various benefits of trusts. Many people, in particular, have questions about how income tax impacts trusts. Here we'll look at some basic trust income taxation matters.

Beginning with definitions, a trust is technically a legal entity involving a grantor, trustee and a beneficiary. Every trust must have a specific purpose, and is governed by the law of the state in which it is formed. It may be formed by declaration, transfer of property by the owner during his or her lifetime or at death, or by a power of appointment.

The grantor establishes the terms of the trust, which is in fact a relationship between the grantor, the trustee, and the beneficiary. The trustee is the person who obtains legal title to trust assets and who administers the trust assets on behalf of the beneficiaries. The beneficiary is, of course, the person entitled to receive benefits from the trust.

There are a number of different distinctions and types of trusts, including simple trusts, complex trusts, grantor trusts, irrevocable and revocable trusts, testamentary and inter vivos trusts. The first thing to realize is that trust taxation is governed by the Internal Revenue Code, while trusts themselves are governed by state law.

Trusts are required to file an income tax return for every taxable year in which the trust has at least $600 of income or when the trust has a non-resident alien as a beneficiary. No tax return must be filed, though, for grantor trusts if the grantor himself reports all income on his or her personal income tax return.

In our next post, we'll continue this topic, looking at how trusts compute income tax liability, assignment, charitable contributions, and gift taxes.

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